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evaluation of expansion options

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Moon Shine has decided to expand into related business. Management estimates that to build a facility of the desired size and to attain capacity operations would cost $ 285 million in present value terms

Alternatively, the firm could acquire an existing division with the desired capacity. One such opportunity is the division of another company. The book value of the division's assets is $145 million and its earnings before interest and tax are $30 million. Publicly traded comparable companies are selling around 12 times current earnings. These companies have debt-to-asset ratios averaging 40 percent with an average interest rate of 10 percent.

a) Minimum price the owner of the division should consider for its sale, using a tax rate of 34 percent.
b) Maximum price the acquirer the acquirer should be willing to pay.
c) Does it appear that an acquisition is feasible?
d) Would a 25 percent increase in stock prices to an industry average price-to-earnings ratio of 15 change your answer to (c)?
e) Referring to the $285 million price tag as a replacement value of the division, what would you predict would happen to acquisition activity when market values of companies and division rise above their replacement values?

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DATA
Moon Shine
Cost of building $285 Million
Other division
Book value of division's assets $145 Million
EBIT $30 Million
Earning multiples 12 times
Debt to assets ratio 40%
Interest rate 10%
Tax rate 34%
Workings
Book value of debt = Book value of assets *debt to assets ratio =$145 *40% = $58 Million
Interest expense= Debt *interest rate =$58*10%= $5.80 Million
Calculation of net earning
EBIT $30 Million
Less: Interest expenses $5.80 Million
EBT $24.20 Million
Less: ...

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See Also This Related BrainMass Solution

Asor Products Inc. Case Study: NPV and Strategic Analysis

Can you help me get started on this assignment?

Jenny Rene, the CFO of Asor Products, Inc., has just completed an evaluation of a proposed capital expenditure for equipment that would expand the firm's manufacturing capacity. Using the traditional NPV methodology, she found the project unacceptable because
NPV traditional = - $1,700 < $0

Before recommending rejection of the proposed project, she has decided to assess whether there might be real options embedded in the firm's cash flows.
Her evaluation uncovered three options:

Option 1: Abandonment: The project could be abandoned at the end of 3 years, resulting in an addition to NPV of $1,200.

Option 2: Expansion: If the projected outcomes occurred, an opportunity to expand the firm's product offerings further would become available at the end of 4 years. Exercise of this option is estimated to add $3,000 to the project's NPV.

Option 3: Delay: Certain phases of the proposed project could be delayed if market and competitive conditions caused the firm's forecast revenues to develop more slowly than planned. Such a delay in implementation at that point has a NPV of $10,000.

Jenny estimated that there was a 25% chance that the abandonment option would need to be exercised, a 30% chance that the expansion option would be exercised, and only a 10% chance that the implementation of certain phases of the project would have to be delayed.

LG6

a. Use the information provided to calculate the strategic NPV, NPV strategic, for Asor Products' proposed equipment expenditure.

b. Judging on the basis of your findings in part a, what action should Jenny recommend to management with regard to the proposed equipment expenditure?

c. In general, how does this problem demonstrate the importance of considering real options when making capital budgeting decisions?

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